The Returns On Capital At Softline Holding (LON:SFTL) Don't Inspire Confidence

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Softline Holding (LON:SFTL), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Softline Holding is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.065 = US$34m ÷ (US$1.1b - US$537m) (Based on the trailing twelve months to March 2022).

Therefore, Softline Holding has an ROCE of 6.5%. In absolute terms, that's a low return and it also under-performs the IT industry average of 9.9%.

Our analysis indicates that SFTL is potentially undervalued!

Historical performance is a great place to start when researching a stock so above you can see the gauge for Softline Holding's ROCE against it's prior returns. If you're interested in investigating Softline Holding's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Softline Holding's historical ROCE movements, the trend isn't fantastic. Over the last three years, returns on capital have decreased to 6.5% from 23% three years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Softline Holding has decreased its current liabilities to 50% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From Softline Holding's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Softline Holding is reinvesting for growth and has higher sales as a result. Despite these promising trends, the stock has collapsed 74% over the last year, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

On a separate note, we've found 1 warning sign for Softline Holding you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.